Parallels Between the Current Market and the Run Up to the May Correction

Guest commentary by Michael A. Gayed.

Is it May all over again?

Its easy to get swept away in the string of market returns higher. Its been a spectacular run since September after all. But market declines often come when investors least expect them. To get a sense of the likelihood of a coming drop, we need to look at the internals of the market.

I am noticing a number of parallels that remind me of the lead up to the May correction we experienced this year:

1.      Investor Bullish Sentiment – According to the American Association of Individual Investors (AAII), its Investor Sentiment Survey indicates that 51% of investors are bullish on the market going forward. A couple of weeks before the May correction, that number was 48%. To put that into context, the historical long-term average is 39%. Similar to the lead up to May, bullish sentiment has reached extreme highs.

(Click on all images to enlarge.)

Source: Pragcap.com

2.      Mutual Fund Cash Levels – The percentage of cash held by mutual funds has reached all time lows again. The next highest low was reached back in April of this year. This indicates that mutual fund managers are “all-in”, another contrarian sentiment indicator


Source: http://home.comcast.net/~RoyAshworth/Mutual_Fund_Cash_Levels/Mutual_Fund_Cash_Levels.htm

3.      Put/Call Ratio – The ratio of put buying (protection/insurance) to call buying (speculative bets on further price increases) is reaching for April lows, indicating complacency is occurring.

4.      Beta Ratios at Year Highs – Taking a look at the price ratios of the Russell 2000 Small Cap ETF (Symbol: IWM), Industrials sector(Symbol: XLI), and Consumer Discretionary sector (Symbol: XLY) relative to the S&P 500 ETF (Symbol: SPY), we can see that these beta-driven areas have all reached April highs relative to the broader S&P 500 ETF. This might mean we have reached an exhaustion point in risk-taking.

My purpose in presenting this is not to suggest a market crash is coming, but rather that there are warning signs that the market’s advance may stop as suddenly as it did earlier this year.

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Michael A. Gayed, CFA, Chief Investment Strategist for Pension Partners LLC and a regular contributor to Seeking Alpha.

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Please Note: This article expresses the views of the author and such views are subject to change without notice. Pension Partners LLC has no duty or obligation to update the information contained herein. Further, Pension Partners LLC makes no representation, and it should not be assumed, that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss. This article is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Pension Partners LLC believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This article, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Pension Partners LLC.

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Portfolioist welcomes your comments, suggestions for articles, and potential guest blogs. Contact byrnesn@folioinvesting.com.


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